In the world of day trading, your ability to read charts is one of your greatest survival tools. To put it simply, historical price action helps us predict future price action. For that reason, we can use a combination of pattern recognition and risk management to place trades with higher probabilities of profitability. Although this process may seem complex, the underlying concept is pretty straightforward and we actually use this type of thinking every single day. We use historical data to recognize patterns and make predictions.
For example, you probably know what times there will be higher traffic on the roads. These examples are oversimplified, but they are all based on the logic that historical patterns tend to repeat themselves. The same logic holds true for day trading. The second crucial part of this predictive strategy is risk management. A restaurant has served bad food three times and is likely to serve it a fourth. Would you bet your life savings on it?
Buying dips and shorting pops is a way of minimizing risk when you are anticipating a certain move. Essentially, you are buying into weakness and selling into strength, meaning you will get better fills when anticipating a move.
You have the option to buy the breakout once it is confirmed OR you can start building a position in anticipation of the breakout. The latter option lowers your risk and increases your upside potential. Accounting for risk is an important part of this anticipation process. You should always know how much you expect to gain if the trade goes in your favor vs.
Failed follow through momentum occurs when a stock tries to breakout above a key price level but fails. This can provide a great intraday short opportunity, especially when the initial move was drastic. You can see a good example of failed follow through momentum in our recent Snapchat IPO trade recap. You can initiate a short position using the high-of-day as your risk level. This indicator can be great for understanding money flow and significant price levels.
VWAP is used by traders and algorithms to identify significant price levels. VWAP is especially beneficial for momentum trading and it offers a variety of applications.
Contrarily, you may initiate a long position as a stock breaks above VWAP. When you plan this type of trade, you can base your risk around VWAP. When a stock goes from red to green, the share price moves from below the previous close to above the previous close. This represents a significant shift in momentum that can be used to plan a trade with set risk around the previous closing price.
Often times, the stock will become more volatile during this momentum shift, providing for great intraday trading setups. While a stock can theoretically drop forever, it will generally find short-term bottoms along its descent. These bottoms can be used to predict a short-term trend reversal, also known as a bounce. When a stock double or triple bottoms, it sets a support level and re-tests that level once or twice.
If the support level holds, we can use it to gauge risk for a trade. Historical data shows patterns that give traders the ability to make educated predictions. Failed Follow Through Momentum Short Trades Failed follow through momentum occurs when a stock tries to breakout above a key price level but fails. Here is what you need to look for: Initial Momentum — Stock has a significant price run earlier in the day High of Day Breakout Attempt — Stock attempts to break out above the current high-of-day Failed Follow Through — The stock may pull back on the first HOD break attempt and try again only to be rejected.
Double and Triple Bottoms Long Trades While a stock can theoretically drop forever, it will generally find short-term bottoms along its descent.More...